As borrowers quickly discover when searching for a mortgage, loan options abound. There are conventional loans and government loans, mortgages with fixed interest rates and adjustable rates, as well as ones with 30-year terms and others that are much shorter.
And then, there are mortgages with balloon payments.
What is a balloon mortgage payment?
Balloon payment definition
A balloon payment on a mortgage is payment for the loan’s outstanding balance. Unlike the typical mortgage with monthly installments for both interest and principal, a balloon mortgage allows the borrower to make lower or no payments for a period of time — sometimes only paying the interest — while the remaining balance is deferred.
This leaves the borrower with smaller, more manageable monthly payments (or no obligation at all) for a specified time. But at the end of this period, a balloon payment for the deferred amount comes due, potentially costing the borrower much more than they’re able to pay at one time.
Balloon mortgages can have either an adjustable or fixed interest rate and varying loan conditions. These kinds of payments are uncommon for most qualified mortgages, which follow strict guidelines that ensure the borrower’s ability to repay the loan. Because of their risk, they’re generally offered only to borrowers with excellent credit and considerable wealth.
Aside from mortgages, some auto and commercial loans may be structured with balloon payments as well.
Is a balloon mortgage worth it?
A mortgage with a balloon payment can help make homeownership more affordable to a borrower on a monthly basis, but it comes with huge risk.
If the borrower doesn’t have enough cash to pay the balance, they could lose their home. While refinancing may avert this situation, it can be difficult to qualify. Typically to refinance, lenders look for a minimum amount of home equity, but if the balloon mortgage only required interest repayments, for example, the borrower would have little to no equity to draw from, and be left with few choices when the payment comes due.
How to know if a mortgage has a balloon payment
You can check whether a mortgage you’re considering is structured with a balloon payment by reviewing the loan estimate document you received from the mortgage lender. Look on page 1, under the “Loan Terms” section, for a field that reads “Balloon Payment.” Here, the lender will indicate either yes or no.
Balloon payments in the pandemic
The passage of the CARES Act in March 2020 allowed financially strapped homeowners impacted by the pandemic to enter mortgage forbearance for up to a year. In the past, borrowers in forbearance may have been required to make a balloon-type payment once the forbearance period ended or at the end of their loan term. Now, however, those with government-secured loans in forbearance won’t be asked to make a balloon payment, and many private lenders are also offering more flexible repayment options.
Mortgages with balloon payments translate into lower monthly costs for a period of time, increasing the likelihood that the borrower will meet their immediate loan obligations. Yet, the heightened risk of default that accompanies balloon mortgages makes them rather rare today. If you’re considering a mortgage with a balloon payment, cautiously evaluate your current financial standing and your expectations for the future before committing to the loan.